Fitch: Brazil's Aviation Crisis Shows Need for Infrastructure Investments & Efficiency Improvements.

CHICAGO -- Fitch Ratings has been following the recent developments in the Brazilian civil aviation crisis and their possible impact on the credit quality of the main Brazilian airline companies, GOL Linhas Aereas Inteligente S.A (GOL) and TAM Linhas Aereas S.A (TAM). A complete ratings list follows at the end of this comment.

Fitch believes that the current crisis and its adverse effects will encourage important changes in the sector as they have highlighted the need for more government infrastructure investments and continued efficiency improvements on behalf of the operating companies. Due to the crisis, the agency expects the profitability of Brazilian airline companies to slightly deteriorate during the fourth quarter of 2006; for the full year, nonetheless, both operators should post their best results ever.

However, Fitch understands that TAM and GOL, the two main Brazilian airlines, have benefited from their position as dominant companies in the national airline sector and the only ones with a truly integrated national network. Moreover, they enjoy competitive cost structures even compared to international standards, and present a solid financial profile and significant cash resources, mitigating short-term risks and sector turbulence. Fitch will continue to monitor the performance of the sector and the evolution of the credit profile of the two companies mentioned above, expecting that they will continue to report robust cash generation and credit ratios compatible with the rating category assigned.

Going forward, sustained growth in the sector, which over the past three years averaged 18% per year, will only be possible if substantial management measures and investments are implemented over the long run and are not just limited to temporary measures to smooth the current crisis. Should the current scenario continue, airline companies might see their credit profile affected due to frustrated growth expectations and the incurrence of additional costs, with a consequent deterioration in future earnings.

The Brazilian airline sector has lived through an abnormal situation during these past three months, and at several occasions being described as chaotic by passengers and airline operators. Among the factors that contributed to such a scenario is a problem already well known in Brazil, the 'infrastructure bottleneck'. The lack of investments were once again evident in Brazilian airports, where the scarcity of efficient infrastructure to support accelerated growth was observed. In turn, the introduction of new operating methods by Brazilian airline companies to improve utilization of their aircraft and the reduction in market share of an important company in the sector contributed to further aggravating the crisis at the end of 2006. The largest airline companies utilize their highly interconnected route network to obtain operational efficiency, maximizing aircraft flightime. Once this network is restricted and interconnections limited, the system becomes inefficient, with flight delays and cancellations generating negative repercussions of economic and social nature.

Fitch's priority is to seek to identify the possible effects on the credit profile of the companies that are assessed by the agency, should this scenario continue, rather than issue an opinion on the causes of the collapse in the Brazilian air transport system of recent weeks. Nevertheless, the recent events show the consequence of reduced government investments in infrastructure and that the sector operates with limited investments in equipment and manpower. The rapid growth in the Brazilian aviation market observed over the past three years has caused such fragilities to become more evident. Regardless of whether or not the present problems are solely due to the absence of adequate technical operating conditions, attributable to a lack of investments, or a combination of that and the airline companies' inefficiency in properly serving the strong demand observed, the fact is that the national airline sector is experiencing a time of crisis that has to be resolved in a responsible manner.

Before the crisis scenario, companies in the sector anticipated a growth of between 12% and 15% for 2007, continuing the strong expansion observed in recent years. The companies have prepared for this growth and invested heavily to expand their aircraft fleet. The factors produced by the sectorial crisis conflict with the national airlines basic strategies: reducing costs and maximizing daily aircraft usage. The flight delays and cancellations observed in recent months are discouraging passengers, many of whom have already made alternative travel plans, with a possible impact on projections for aircraft load factors. In addition, they involve added costs, relative to passenger-related expenses that were not forecasted, the costs incurred with aircraft on the ground waiting for permission to take off, additional personnel expenses and eventual indemnifications that may be sought through judicial measures. The prolonging of this turbulent environment is expected to have a negative impact on the companies' image and operating margins.

The Brazilian civil aviation market has presented strong growth since 2004, increasing from 28 million passengers that year to 36 million in the first 11 months of 2006. This number would tend to be even more relevant when the month of December is included, since the year-end holidays have a significant weight in sector seasonality. In 2006, demand grew 12.9% versus an increased seating capacity of 10.7%. In terms of load factor, GOL and TAM continued to present an improvement in this indicator for the accumulated 11-month period in 2006. However, for the crisis months of October and November, GOL presented an average load factor decline of around 4 percentage points; TAM reckons that the crisis would reduced load factors by 2%. The effects of crisis are still not available for December. Given the significant volume of cancellations and delays, the impact on the companies is expected to be relevant, mainly for TAM, the company with the largest number of canceled and delayed flights, but not immediately impacting its credit profile. For 2007, Fitch expects that competition will intensify in the sector with the return of Varig, more aggressive positioning by Oceanair and BRA, companies that still have limited activities but relevant expansion plans underway, and the delivery of aircraft ordered by TAM (11 airplanes) and GOL (15). An increase in competition resulting in companies being tempted to engage in a harmful fare war, coupled with lower aircraft load factors, would inevitably impact the strong credit profile of the Brazilian airline companies.

GOL Linhas Aereas Inteligente S.A (GOL)

--Foreign Currency Issuer Default Rating (IDR) 'BB+';

--Local Currency IDR 'BB+';

--National Rating 'AA-(bra)'.

The Rating Outlook is Stable.

TAM Linhas Aereas S.A (TAM) -

--Foreign Currency IDR 'BB',

--Local Currency IDR 'BB'

--National Rating 'A+(bra)'.

The Rating Outlook is Stable.

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